Wall Street analysts could not have predicted that a new strain of the coronavirus discovered in the UK and South Africa on Monday would cause the S&P 500 to refuel before it hits the market in future stores, even if the US government did a long-awaited second Covid-19 stimulus deal.
It’s hard to see the future, whether for a day or more.
It is important for investors to remember that Wall Street is going to publish projections for the stock market in 2021. Wall Street is betting that a stimulus deal would keep stocks moving on Monday, and the story of longer-term stock forecasts is unlikely to instill investor confidence.
After the defiant bull market raged from the March pandemic, earnings and target price estimates for the S&P 500 through 2021 are bullish. With just two weeks of trading left in 2020, the S&P 500 is up nearly 15% over the year and 3600. A look at earnings per share and price targets for 2021 from every analyst covering every share in the S&P 500 , shows an optimistic forecast for the next year, with the S&P 500 expected to hit 4000.
Sounds good, but given recent market history, the forecasts are likely to vary slightly or significantly. According to a recent analysis by FactSet, analysts have overestimated the year-end price for the S&P 500 in 12 of the last 15 years. Due to the average overestimation, the S&P 500 could actually end below its current level in 2021.
NEW YORK, NY – APRIL 24: Traders and finance professionals work on the floor of the New York Stock Exchange (NYSE) at the opening bell.
Drew Angerer | Getty Images News | Getty Images
This isn’t the only negative view of the 2021 stock forecast, or the first time the value of Wall Street projections has been challenged. However, the key to the FactSet approach is bottom-up analysis, which examines the projections of earnings per share from analysts covering all S&P 500 companies, rather than the S&P 500 calls from leading market strategists and macro market teams.
“The Wall Street analysts who cover companies want you to look,” said John Butters, senior earnings analyst at FactSet. “Most of the time, they tend to overestimate,” he said. If knowing these predictions from Wall Street is helpful for investors, it is “good to know historical trends as well,” Butters said.
The overshooting of the actual stock market performance is also reflected in the analyst target inquiries for the index. The same bottom-up analysis of the S&P 500, based on company-level EPS estimates for 2021, predicts the S&P 500 will hit $ 169, which would mark a new record high for the index. However, if you predicted that analysts in the past also overestimated performance by this metric, you are right. In the past 20 years (2000–2019), industry analysts overestimated the final EPS figure by 7% a year in advance, according to FactSet.
There are a few reasons, if not optimistic about the stock market outlook, to be at least a little less pessimistic. A few years, especially those corresponding to the 2008 financial crisis, make the forecasts look even worse than usual. Without 2008, the analyst overshoot of actual performance of the S&P 500 over the past 15 years went from over 9% to a failure 3.4% back. And the fact that analysts exceeded actual market performance 12 times out of 15 means they fell below it three times. When looking at the forecast for the S&P 500 target price, the analysts have underperformed actual performance in seven of the last 20 years.
Which path will the analysts take in 2021?
The 2021 market will begin with greater uncertainty
Given the uncertainty surrounding Covid-19 and the pace of economic recovery in the US and around the world, it won’t be easier for analysts to call the S&P 500 annually, even if vaccination campaigns and government incentives are successful. Not to mention, many Wall Street companies still fail to provide guidance given the uncertainty in the world.
“The expectation is that the result will recover at some point, 2021 or 2022, but when does that happen?” Butters asked.
He believes that it may be better to watch how many companies come out with guidance early next year when they release fourth quarter 2020 results than the year-end projections currently released.
There is room for earnings growth. Analysts slashed EPS projections in March, and there has been a steady, slow increase since June, but it still falls far short of previous pre-Covid expectations.
“There is a chance that if things change faster we will see a big increase in estimates like we saw a big decrease,” Butters said, but obviously he’s not about to make the prediction.
All he can say for sure is that history shows that Wall Street analysts tend to be more conservative in forecasting when it is a short-term view (around a quarter) and that the forecast is more optimistic in the longer term.
During a typical profitable season, an average of 72% of companies beat estimates. Over the longer time horizon of six months to a year, however, the analysts’ targets are in the upper range.
There is nothing special about Wall Street’s problems trying to predict the future. Experts from complicated disciplines do not make precise predictions, according to the most famous book on the subject, Superforecasting, by Philip Tetlock and Dan Gardner. Their research found that the average professional was a terrible forecaster, regardless of experience and degrees. In their famous summary of expert predictions, they wrote that it was “about as accurate as a chimpanzee throwing arrows”.
As investors plan their portfolio strategies for 2021, the history of the S&P 500 year-end calls suggests that investors may want to be careful about what they want – they just may not get it.